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3 Reasons to Be Skeptical of the Pfizer-Allergan Mega-Merger

U.S. stocks are little changed in late Monday morning trading, with the Dow Jones Industrial Average (DJINDICES:^DJI) and the S&P 500 (SNPINDEX:^GSPC) up 0.05% and 0.25%, respectively, at 12 p.m. EST. Shares of Pfizer and Allergan PLC, meanwhile, are down 1.86% and 2.43%, respectively, as the companies announced they are merging in a blockbuster deal with a combined enterprise value of roughly $160 billion, capping what was already a record-setting year for pharmaceutical industry M&A.

Investors appear to be taking a dim view of today's merger announcement, with shares of both the acquirer and the target declining. This columnist believes the market has good reason to be skeptical.

Earlier in its history, Pfizer was thought to be a smart and skilled acquirer. In 2004, the Boston Consulting Group cited Pfizer as an example in its studyGrowing Through Acquisitions: The Successful Acquisition Record of Acquisitive Growth Strategies:

Pfizer is perhaps the most dramatic example in the pharmaceutical industry of a company that has built a strong competitive position and substantial shareholder value, at least in part by means of aggressive acquisition.

Alas, past performance does not guarantee future results. Over the following decade, during which Pfizer completed the huge $68 billion acquisition of Wyeth, shares' annualized total return was (4.2%), underperforming the S&P 500 by more than 11 percentage points.

Six-plus years on, the evidence regarding value creation (or destruction) linked to the Wyeth acquisition is not clear-cut -- not the result shareholders might have hoped for, particularly in light of the size of the transaction.

Another point of concern regarding today's proposed transaction is the fact that it appears to be heavily driven by tax considerations. In a so-called "inversion" deal, the combined company will keep Allergan's Irish tax domicile, such that Pfizer expects its tax rate to decline to 17% to 18%, substantially below its current 25% rate. Yes, a lower tax rate benefits shareholders, but this columnist would prefer to see an ironclad business case for the deal.

Finally, most of the deal is being paid for in shares, with Pfizer capping the amount of cash to be paid out at $12 billion. That would be favorable to Pfizer shareholders if the company were using an overvalued currency; unfortunately, Pfizer shares look somewhat undervalued right now (or no better than fairly valued, in any case).

Despite these potential concerns, there is one group that will never argue against the deal: The financial "advisors" working on the transaction, who will split transaction fees that could exceed $100 million (Goldman Sachs, Morgan Stanley and J.P. Morgan are among the chosen group). That kind of number creates an enormous incentive for bankers to push the deal.

As professor Aswath Damodaran writes, "[M&A bankers'] success is often measured by where they fall in the deal table rankings. ... [T]he rankings are based upon the dollar value of deals done ... . The bigger the deal, the worse the advice you are likely to get."